Earthquake damage, San Salvador, October 1986
Courtesy Inter-American Development Bank

El Salvador's economy has always been highly dependent on a single agricultural export commodity. Following independence, indigo was the most important commodity to the Salvadoran economy and represented most of the country's exports. In the midnineteenth century, however, indigo was replaced in the European and North American markets by artificial dyes. Consequently, indigo producers were forced to seek alternative commodities that would permit them to maintain their level of earnings. Fortunately for El Salvador's wealthier landowners, the decline of indigo was concurrent with the rise in world demand for another crop that thrives in tropical climates--coffee. The coffee export sector dominated the Salvadoran economy by the 1870s.

During the 1950s and 1960s, coffee export earnings helped fuel the expansion of cotton and sugar cultivation (which subsequently became the country's second and third most important export crops, respectively) and financed the development of light manufacturing. In fact, in the years immediately following the Revolution of 1948, which reduced the direct political influence of the coffee interests, the taxes on coffee exports were increased tenfold in order to finance industrialization. These funds were used to develop the country's transportation infrastructure and electricity generation capabilities.

Light manufacturing developed rapidly in El Salvador during the 1960s, largely as a result of the establishment of the Central American Common Market (CACM--see Glossary). El Salvador's industrial development hitherto had been hindered by the absence of a domestic market for these goods. The small class of wealthy landowners generally preferred high-quality imports, while the large lower class lacked the disposable income to buy most manufactured goods. The CACM, however, improved this situation by expanding the market for Salvadoran goods through the elimination of intraregional trade barriers. As a result, the manufactured goods produced in El Salvador became more competitive in Honduras than those from the United States or other non-Central American countries. The CACM-stimulated industrial growth never threatened the predominance of coffee production within the Salvadoran economy, however. Moreover, the stimulus proved to be short lived because the CACM broke down in the 1970s.

The civil conflict and the disincentives inherent in some government policies disrupted coffee, sugar, and cotton production during the 1980s, resulting in a general lack of dynamism in the Salvadoran economy (see table 4, Appendix). GDP increased at a 4.3 percent annual rate between 1965 and 1978 but, reflecting the effects of civil unrest, declined by 23 percent between 1979 and 1982. The economy modestly expanded between 1983 tof7c to 1986, with average annual growth rates of about 1.5 percent. The country's total GDP equaled approximately US$4.6 billion in 1986. Real per capital GDP was approximately US$938.

During the 1960s and 1970s, gross capital formation increased by an impressive 6.6 percent annual rate, reflecting investor confidence and the positive effects of the CACM. Between 1980 and 1986, however, as investors reacted to the instability caused by the civil conflict, depreciation outstripped investment at an annual rate of 0.8 percent. Private outflows of capital slowed in 1987, resulting in a less drastic capital account deficit of US$34 million, less than a quarter of the outflow registered in 1986.

El Salvador`s economy expanded an estimated 2.5 percent in 1987, representing the largest single-year gain since 1978. This moderate improvement in the country's overall economic activity was primarily the result of a modest rebound in agricultural output and a substantial reactivation of construction activity led by the private sector. Gains in construction investment reflected efforts to replace structures damaged in the 1986 earthquake, which caused an estimated US$1 billion in damage to the country's buildings and infrastructure. Two additional sources of growth were transfer receipts (mostly from Salvadorans working in the United States) and official grants from the United States government. In 1987 net private transfers, or transfer receipts, accounted for over 4 percent of GDP, while grants or official transfers from the United States government represented 5 percent.

Although 1987 was the Salvadoran economy's most positive year since the beginning of the civil conflict, attempts to measure and judge the economy's health should compare the country's economic performance in 1987 with its most recent economic peak in 1978. Using this method to evaluate El Salvador's economy casts a less favorable light than the alternative year-to-year measurement. Although El Salvador's economy grew rapidly in 1987 compared with other years in the 1980s, real income was still almost 20 percent below its 1978 level.

One important but ominous indicator of future economic health was the low level of gross fixed capital formation in 1987, which remained substantially below the levels necessary to expand production capacity and generate productivity gains. Gross fixed capital formation, 14 percent of GDP in 1987, was at a level significantly below those experienced in the 1960s and 1970s.

Consumption expenditures increased by less than 1 percent in 1987, primarily because of an 8.7 percent drop in general government expenditures. Because the International Monetary Fund (IMF--see Glossary) supervised the economic stabilization program, the government was obligated to reduce its budget deficit. Also, because revenue sources consistently failed to close the gap between expenditures and revenues, the government was forced to reduce consumption expenditures in 1987.

Data as of November 1988